Australia: Introduction of the Exploration Development Incentive (EDI) tax credits

Tax Legal Insight
Last Updated: 9 July 2014
Article by Betsy-Ann M. Howe and Adam Levine

In the 2014 Budget, the Federal Government announced that it would introduce Exploration Development Incentive (EDI) tax credits to encourage and stimulate growth in the junior mining industry. This is a simpler approach to other incentives previously considered and similar to that used by Canada in relation to its tax incentives for mineral exploration.

The measure had previously been outlined in the Coalition's Policy for Resources and Energy and a Treasury discussion paper had been released in March 2014. Further details of the scheme have just been released which, once implemented, will apply retrospectively from 1 July 2014. The EDI is designed to allow shareholders in certain junior miners to receive tax credits for expenditure incurred by the company, and apply those tax credits against the shareholder's own personal tax liability. The tax credits will be available to all shareholders or, at the election of the company, only to holders of shares issued after 30 June 2014.

Draft legislation has not yet been released, but the Government has undertaken to further consult with stakeholders in relation to the design of the measures.

A welcome development for the junior mining industry

The introduction of the EDI will come as welcome news to junior exploration companies who are looking for ways to fund mining exploration in Australia. Recent figures from the Australian Bureau of Statistics show that since mineral exploration in Western Australia (WA) peaked at AUD603 million in the June quarter of 2012, it has fallen by two thirds to AUD206.2 million in the March quarter of 2014 which means that mineral exploration across WA is now at its lowest level since the March quarter of 2007. This is largely due to the difficulties in raising the necessary funds – either from debt or equity. The introduction of the EDI is likely to spark great interest from investors seeking tax benefits for investing in junior exploration companies.

EDI eligibility

The EDI will only be available to "disclosing entities", being listed companies and certain widely held unlisted companies. Companies with no taxable income will be eligible for the EDI. However, the scheme will exclude companies that have commenced resources production as well as companies connected or affiliated with an entity that has commenced resources production. It is unclear how the "affiliation or connection" test will be applied in practice, though this would likely exclude exploration ventures of corporate groups that include a production component. Participation in the EDI is voluntary.

How will shareholders benefit?

Companies participating in the EDI and providing exploration credits to shareholders will need to make an irrevocable choice to either provide exploration credits to all shareholders, or only to holders of shares issued after 30 June 2014. This choice is intended to allow the company to decide which option best assists it in continuing to explore for new mineral deposits.

Where an entity elects to provide exploration credits to holders of shares issued after 30 June 2014, any shares issued by the entity after 30 June 2014 will need to be traded as a separate class of shares given that the rights and restrictions attaching to shares issued after 30 June 2014 will be different to the entity's other classes of shares. In order for the separate class of shares to be quoted and traded on the Australian Securities Exchange (ASX), the entity will need to apply to ASX for the quotation of the securities and meet the relevant conditions set out in the ASX Listing Rules.

Administratively, an entity will need to maintain adequate records of those shareholders who are entitled to receive tax credits under the EDI.

What expenditure will be eligible?

The EDI will apply to eligible greenfields exploration expenditure incurred from 1 July 2014. This will broadly include expenditure incurred on activities for the purpose of determining the existence, location, extent or quality of a new mineral resource in Australia on land the subject of an exploration licence.

So that the definition does not extend beyond greenfields exploration, the definition would not include expenditure on activities normally associated with feasibility, including activities aimed at determining whether it is economically (including technically) feasible or commercially viable to proceed to development, or how best to develop a known mineralisation, would be excluded from the EDI.

Specifically, activities covered will include geological mapping, geophysical surveys, systematic search for areas containing minerals, except petroleum or quarry materials, and search for minerals by drilling or other means for such minerals within those areas. The EDI will only apply to expenditure on exploration for minerals in Australia and will not apply to exploration for:

  • quarry materials
  • shale oil
  • petroleum, including coal seam gas, and any naturally occurring hydrocarbon or naturally occurring mixture of hydrocarbons, whether in a gaseous, liquid or solid state
  • geothermal energy resources.

Capping the EDI

As announced in the 2014 Budget, Government expenditure in relation to EDI credits will be capped at AUD25 million for exploration expenditure incurred in 2014, AUD35 million for exploration expenditure incurred in 2015-16 and AUD40 million for exploration expenditure incurred in 2016-17. In order to ensure the caps are not breached, an "ex-post modulation approach" will be applied by the Australian Taxation Office (ATO).

In broad terms an ex-post modulation would require companies to notify the ATO of their 'eligible loss' and eligibility for the scheme in respect of the previous financial year (the expenditure year), and lodge their tax return by a cut-off date, for instance 1 March following the expenditure year. The ATO would then calculate the total 'eligible losses' reported for the expenditure year. If the total exploration credits that would result from the 'eligible losses' exceed the cap set by the Government for the expenditure year, the ATO would calculate an appropriate modulation factor (so that the cap is not exceeded) and advise eligible companies of the proportion of their 'eligible losses' they will be entitled to provide to shareholders as exploration credits.

Companies will not be able to flow through the benefit of more than their 'available loss', that is, the modulation factor multiplied by their expenditure year 'eligible loss'.

While this approach was considered to be the least administratively complex, and would enable an earlier start to the EDI, it does mean that investors are unlikely to be able to determine the quantum of the exploration credit if they were to invest in the expenditure year unless they are able to reliably estimate both the company's likely 'eligible loss' and total 'eligible losses' for all eligible companies in that year.

Companies seeking to raise capital from investors on the basis that the funds will be used for eligible greenfields exploration under the EDI and thereby offering tax credits to such investors, will need to ensure that any offer document fully and adequately outlines what the funds raised will be used for. For example, it is common that the proceeds of funds are used for a variety of purposes including, exploration, capital expenditure and the costs of the offer. If it is intended that the money raised from the capital raising will fund costs other than exploration, investors will not be able to claim tax credits for such expenditure as it is not eligible expenditure under the EDI. There will also need to be proper disclosure in the fundraising documentation around the EDI regime.

It will be important for entities participating in the EDI to keep adequate, detailed and up to date records of its eligible greenfield exploration expenditure including payments into and out of its EDI accounts.

The treatment of exploration credits

Companies wishing to provide credits to shareholders will need to make adjustments to tax losses by reducing the amount of the tax loss available to carry forward by an amount equivalent to the credits it wishes to provide to its shareholders. In effect, the rules will allow shareholders to realise the benefit of expenditure in the form of credits, as opposed to the expenditure sitting in the company as a tax loss.

Australian resident shareholders will be entitled to refundable tax offsets equal to the exploration credits they receive. However whilst foreign resident shareholders will also receive the credits, they will not be entitled to use them. Exploration credits will flow through trusts and partnerships in a manner consistent with the rules applying to franking credits. Likewise, corporate shareholders will receive similar benefits to those they obtain under the rules that apply to franking credits.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

K&L Gates has been awarded a 2012 EOWA Employer of Choice for Women citation acknowledging our commitment to workplace diversity.

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